China Data Falls As Expected, Reforms Moving Forward

China's PMI data for August came in lower than the previous month but the market reacted with a yawn in Hong Kong and Shanghai on Monday. Both the Hang Seng Index and all of the major indices of the Shanghai Stock Exchange rose today. Markets are closed in the U.S. in observance of the Labor Day holiday.

The National Bureau of Statistics, China's official data source, said that PMI fell to 51.1 in August from 51.7 in July. Consensus had it falling to 51.2. The decline was below China's historical average for August PMI, but it came in line with the HSBC flash PMI figure, the main private indicator watched by the market.

The decline in PMI was broad-based, led mainly by output and new orders, with the new orders index falling to 52.5 from 54.2 in July. The numbers are still plus-50, which indicates positive growth overall.

However, the recovery in China remains somewhat of a see-saw. "The data suggests that China's shallow growth recovery has started to lose momentum, likely because of the ongoing property market correction," wrote Nomura research analysts led by Chang Chun Hua in Hong Kong.

China PMI expansion slowed in August, but remains in plus territory. The government orders new construction projects, trying to keep its promise to deliver 7.5% growth this year as the all-important real estate market continues to deflate.

Despite that call, Nomura has kept its growth forecast of 7.5% in the third and 7.6% in the fourth, with 7.5% for the full year, as Beijing has already foretold.

"From our perspective, pinpointing one number from the next is not a good way to view China," said Marc Tommasi, a portfolio manager for the Manning & Napier International Equity Fund (EXITX ). The fund is up 33.6% over a five year period, beating the MSCI Emerging Markets Index but far below the MSCI World Index.

"We are still in a choppy environment globally," Tommasi said. "China has its own domestic issues with real estate, primarily. Beijing does not want the real estate sector to take off again and is trying to manage for better growth, directing incentives to other parts of the country. There is a deceleration in China and in emerging markets in general and that goes back to (ex-Fed chairman Ben) Bernanke’s talk about tapering. That has been pretty negative for growth rates in the emerging world, including China."

In view of softness in growth, China's State Council announced a new round of construction projects last week. This is consistent with its “targeted easing” strategy and objective of stabilizing growth in the short term, while improving quality and efficiency of growth in the longer term.

The State Council stressed the need to speed up projects of health care facilities, including hospitals and clinical centers; to spend on clean energy projects like wind power, nuclear and hydropower and lastly to build air pollution and water pollution control systems as China grapples with environmental degradation.

These are just some of the areas where Beijing is redirecting construction capital away from residential property.

China's new leaders, now more than a year and a half in power, are moving ahead with reforms.

The Standing Committee of the National People’s Congress, China’s top legislature, approved the fourth draft of the Budget Law revision on Sunday. The revision has clarified several principals, including how to manage ballooning local government debt. Chinese municipalities have been working overtime in maintaining their unwritten full-employment policy, and that has led to massive oversupply, be it in key sectors like automotive and solar panel manufacturing, or real estate.

This weekend marked the first time China’s Budget Law has been revised since it took effect in 1995. Given the complications involving fiscal reform and the relationships between Beijing and the local governments, the revision took an unusually long time. The revision started in 2004, and the first draft came out only in 2011.

Jian Chang, a top China economist for Barclays Capital in Hong Kong, said the revised Budget Law will help to establish a more transparent and accountable budgetary system. She also said it would contain the growth of ballooning local government debt (which jumped 67% from end-2010 to 17.9 trillion yuan -- roughly $2.7 trillion --- in June 2013) and its gradual resolution.

Real estate, local government debt, and massive oversupply have turned investors sour on China. Despite the constant barrage of a so-called hard-landing by financial pundits, Chinese equities as tracked by the iShares FTSE China (FXI) exchange traded fund have outperformed the MSCI Emerging Markets, Brazil, Russia and India since 2011. Taken longer out, however, FXI remains an underperformer over the last five years, up just 1.6% while the MSCI Emerging Markets Index is up 25.10%.